Dazed and Confused About the Market

April’s unemployment numbers jumped to 14.7%. The market was up 13% in April!

Earlier this week, Disney cut its dividend after reporting a 93% drop in earnings. The next day, it’s stock was up 4%!

How can the market move higher with so much bad economic news around? It defies common sense. Or does it?

If you’re confused about what’s going on in the stock market, I thought I’d add to it with some help from Peter Bernstein:

To put the matter into another more puzzling framework, we can say that today’s stock prices do not really forecast what investors think business conditions will be like some six months or so hence, but rather what investors think stock prices will be some six months or so hence! If investors as a group think business conditions and therefore stock prices will be higher six months in the future, they will buy stocks now and refrain from selling them until the level of stock prices reaches a point where they agree with what that price level is predicting, and vice versa on the downside. But the problem is really much more complicated than that, because stock prices six months ahead will not only be reflecting business conditions at that moment but will also be reflecting what investors expect one year from now, which is even more difficult to predict.

Thus described, and greatly magnified and elaborated in the process of selecting individual issues rather than in making a general market forecast, any type of reliable prediction of stock prices seems like a total impossibility. It is difficult enough to know what we should think on our own about what is going to happen, but that is simple compared with the difficulty of knowing what other people are thinking and will think about a future that never holds still, even for an instant.

The market is not concerned with what’s already happened but what could happen next. In short, it’s forward-looking. The market aggregates expectations. It collates millions of guesses — the good, bad, and ugly — into stock prices.

For the most part, the collective guesses do a good job. So much so, that changes in the market typically precede changes in the business cycle.

To complicate it, these expectations are in constant flux. They can quickly change. They can be irrational at times — like when a huge chunk of the aggregated millions come to a biased consensus, it can lead to bubbles and crashes.

Of course, all this complexity shows the futility in trying to predict the market. It’s beyond difficult. It’s a game of guessing what the average guesser — who is trying to do the same as you — believes future stock prices will be.

The important thing to remember is that the market always looks forward. So the next time some good news is reported and the market moves lower, now you know why. The market anticipated it. It’s counterintuitive, but true none the less.